The Money Tree

Safely Generating Income in Retirement

New Trade – L Brands (LB)

Posted by mounddweller on August 9, 2018

Fellow Investors,

Today I initiated a new kind of trade.  It has two parts, one consists of being long the stock and the other is being short puts.  The strategy involves identifying and taking advantage of repeatable patterns of seasonality in the movement of a particular stock’s price.  Not all stocks exhibit this type of seasonality but those that do can be traded for short-term profits.

The stock I chose for my first attempt at this type of trade is LB, L Brands.  LB is one of those currently out of favor retailers.  It has two major chains, Victoria’s Secret and Bath & Body Works.  It also operates two smaller chains, Pink and Henri Bendel.  It also has an international segment for its Victoria’s Secret and Bath & Body Works stores located outside the U.S.

I chose LB as my first try for this type of trade for two reasons, (1) it is currently trading at a very depressed price, and (2) it exhibits a particularly strong period of seasonality.

First, let’s talk about the reasons for the very depressed price.  Currently, sales at domestic Victoria’s Secret locations are faltering.  Same store sales comps are declining.  Victoria’s Secret generated more than half of L Brands yearly revenue, 58.5% in 2017.  Thus, Mr. Market is worried.  However, I think Mr. Market has overreacted.  Since peaking at $62.95 at the close on December 26, 2017 LB has fallen 50%.  It closed today at $31.51.  However, the other 41.5% of L Brands business is doing just fine.  Sales at Bath & Body Works are doing particularly well.  International operations are also doing well, including those of Victoria’s Secret.  The result is that the company remains solidly profitable.  In Mr. Market’s defense there are a couple of other risks that are being priced in, (1) LB has doubled its long-term debt over the past 8 years, and (2) it pays a quarterly dividend of $0.60 which is currently just barely being covered by free cash flow.

Below you’ll find a couple of charts showing key financial information.  In looking them over I think you’ll reach the same conclusion I did, the situation isn’t nearly as dire as Mr. Market would have you believe.

Earlier today L Brands announced its July sales.  The news continues to be bad for Victoria’s Secret but overall it was a positive report.

  • It reported overall sales increased 10.7% Y/Y to $849.7M in July.
  • Comparable sales were flat for the month. Comparable sales fell 2% if only the chain’s stores are tallied up.
  • Bath & Body Works saw a 10% increase in comparable sales, while Victoria’s Secret turned a -4% comp.
  • The company says it expects to report Q2 EPS toward the high end of its previous guidance range of $0.30 to $0.35 per share.

These results further strengthened my belief that results will overall continue to be favorable in the upcoming all important 3rd and 4th quarters of 2018.  This bodes well for a strong performance in its seasonally favorable period which generally runs from August through December.

Over the past 10 years the stock price of L Brands has done very well in the last 5 months of the year.  Initiating a trade on the first trading day in August and closing it on the last trading day of the year in December yielded the following results.

As you can see this trade over the past 10 years has been successful 80% of the time.  We all know what was happening in 2008 so it shouldn’t be a surprise to see that initiating this trade that year would have resulted in a large loss.  A far smaller loss would have been recorded in 2016.  In 2012 the result would have been a very small gain had it not been for the payment of a $3.00 special dividend.

Now, let’s discuss the specifics of the trades I placed earlier today.  As I mentioned in the opening paragraph it has two parts.  First, I purchased 100 shares of LB at a price of $32.20.  The stock faltered later in the day.  Had I been a bit more patient I could have gotten in a bit lower.  It closed today at $31.51.  The second part of the trade consisted of selling to open (STO) two JAN 2019 put at a strike price of $30.  The premium on each was $2.40.

I think it is reasonable to expect that LB will perform similarly to last year in this seasonally favorable period.  Thus, my target price by year-end for LB is $40.  Should LB get to $40 my ROIC (inclusive of the two $0.60 dividends to be paid in September and December) would be 27.95%.  Annualized my return would be 71.3%.

Now let’s look at the potential returns of my two short puts.  Should they expire out of the money (OOM) on January 18, 2019 my ROIC will be 8%.  Annualized my return would be 17.9%.

Now let’s look at the downside potential of this trade.  If the stock doesn’t perform as expected what does my downside look like?  I can’t see it falling significantly below $30 but let’s assume I have the stock put to me at $30 in January and that I continue to hold the original 100 shares purchased at $32.20.  My net cost on the assigned 200 shares will be $27.60 ($30 – 2.40).  My net cost basis on the 300 shares will be $29.13.  The stock currently pays $2.40 in dividends ($0.60 per quarter).  Thus, the dividend yield on my 300 shares would be 8.2%.  I can then either choose to continue to hold the stock and collect the substantial dividend or I can begin selling $30 covered call options until I get called away.

Only time will tell how my initial foray into trading seasonality turns out.

Best Regards,

Troy

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